Recent Comments

Victory!

* Anatole Kaletsky: Associate Editor of The Times* Professor Norman Stone: Professor of International Relations and Director of the Russian Centre at Bilkent University, Ankara.* Alexei Pushkov: Anchor of the most popular Russian TV programme “Post Scriptum” which has considerable influence on Russian public perception of international events.

Speakers against the motion:

* Edward Lucas: Central and Eastern Europe correspondent for the The Economist and author of The New Cold War: How the Kremlin Menaces Both Russia and the West (2008).

Thursday, March 26, 2009

FRENCH politicians seem to see no benefit from economic integration with eastern Europe. The industry minister wants to “repatriate” jobs from Slovenia. President Nicolas Sarkozy says it is unacceptable that French manufacturers make cars for the French market in the Czech Republic.

That may just be rhetorical pandering to the protectionist views of the French public. But it is still offensive to the east Europeans, and could prompt a severe response—such as a boycott of French-made products.

Since 1989, the ex-communist countries have played by western rules. They have stabilised, privatised, liberalised, and opened up—the kind of wrenching economic reform that is the stuff of nightmares for the cosseted workers of old Europe. True, the easterners could have gone further (especially in reforming public finances, state bureaucracy and education). With pitifully little debate, they had to swallow a colossal (and largely French-drafted) European rulebook, with an array of stupid and unpleasant rules and penalties for breaking them, on everything from sugar prices to school kitchens.

While countries such as Britain sit neurotically on the sidelines, the new members yearn to gain admission to EU clubs such as Schengen (visas), Prüm (policing) and of course the euro zone.

That was in these countries’ own interest. Paying a price to be in the clubs that matter was better than staying outside. Yet the easterners’ feel their enthusiasm and cooperativeness have met little gratitude in the west. Their occasional bouts of chippiness and clumsiness are blown out of all proportion. The failure of Romania and Bulgaria to meet anti-corruption targets has tainted the whole region’s image. The Atlanticist loyalties of the new members have been mocked and distrusted.

France was in the forefront of such criticism, and also led the resistance in “old Europe” to the extension of the single market to labour and services. The new member states are still second-class citizens of Europe when it comes to working abroad or exporting their brainpower.

Now France is close to a head-on clash with the fundamental principles of the single market in goods. The next stage could be preferential treatment of domestic producers in government tenders. After that, it is easy to see a slide towards real protectionism in Europe. With the economic glue that holds the EU together weakening, the political links will fray too. In a race to the bottom, the biggest and richest countries will do best (or least badly). The poorer and smaller ones will be left humiliated, impoverished and resentful.

It would be rash to rely on the competition directorate and EU law to stop this dangerous drift. Much better would be to apply a sharp dose of economic pressure. Stroppy French workers may not realise it, but the ex-communist countries are one of their country’s biggest export markets. Renault, for example, sells more than 1m vehicles in eastern Europe. In 2008, France exported €21 billion ($28.5 billion) to the new member states of the EU (compared with €23 billion to the United States).

Boycotting all “French” goods would be a blunt instrument. Many French-badged cars are actually made in places like Poland. And many French-made products are not easily substitutable (Lithuanian šampanas has its charms, but even its die-hard fans don’t quite consider it an alternative to champagne).

But a slogan on the lines of “Aux armes, citoyens de la nouvelle Europe! Plus rien de Français!” would deliver a timely message. Georgian wine, Hungarian foie gras, Polish salami, Skoda cars, Italian fashion and skiing in Slovakia are all alternatives to the French-made offerings. Even—if you want to be really insulting—British cuisine.

Friday, March 20, 2009

IMAGINE some mythical countries called Badland, Eastland, Rohan, Northland, Southland and Midland. At the end of the 1990s, say, oil is found off the shores of Midland. A number of ethnic Northlanders live in the area of the oil find, and hence Northland claims the right to the oil. This leads to a conflict between Midland and Northland.

The conflict simmers for a few years, and escalates when Northland attacks Midland, conquering large swathes of land and sea, among them those containing the oil. Outsiders intervene and a United Nations force called UNMIMA (United Nations’ Mission in Midland) is created. UNMIMA successfully brokers a cease fire deal, and Northland withdraws. But the vacuum is filled by an irregular military force.

The UN Security Council then requests that NATO lead a multinational peacekeepng force to the conflict area.

That is the scenario for Cold Response, the annual military exercises in Norway that are running until March 25th of this year. Around 7,000 soldiers from 14 countries are participating. Some are part of the NATO-led peacekeeping force. Others will be part of the forces of other countries, such as defeated, resentful Midland and the irregulars from Northland.

Clearly, this scenario is not a template for a real conflict, unlike in cold-war days. Then NATO’s military exercises in Germany were broadly based on one central scenario: a huge Soviet conventional attack, and a desperate attempt to hold it back long enough for reinforcement from America to arrive. Nobody worried about Austrian nationalists seizing bits of northern Italy, or a reopening of the Schleswig-Holstein question.

The Cold Response scenario is clearly hypothetical. It has elements of last summer’s Georgian war, but with a Baltic flavour. Leave out the oil (and call it a fight over a port or a pipeline) and allow for Midland to be more like neutral Moldova than NATO-member Latvia.

In real life, if Russia was Northland (or supporting it) it is hard to see how the UN Security Council would be able to mandate any kind of intervention. Cynics might also wonder how enthusiastically Germany would support a NATO mission to quash an insurrection connected with Russia.

Cold Response is interesting not as futurology, but for what it reveals about Nordic defence planning now. Norway, a NATO member, is hosting an exercise in which non-aligned Sweden and neutral Finland are participating in force. It is the clearest sign so far of the burgeoning defence-and-security cooperation between the three countries. Denmark and France also have battalion-strength contingents.

The exercise comes on the heels of the much-delayed report by Thorvald Stoltenberg, a former Norwegian foreign minister. Published in February, it recommended much closer defence cooperation between the five Nordic countries in the Arctic region. It contained no fireworks, concentrating instead on search-and-rescue, and other uncontentious issues. It did not mention Russia as a threat. Countries such as Finland are keen to portray Nordic cooperation as cost-saving exercise, rather than anything more strategic.

Nonetheless, the Cold Response exercises in Norway send some interesting signals, not only to the counterpart countries in the region of the notional “Midland”. It also highlights the distance NATO still has to travel in contingency planning and exercises aimed at bolstering the alliance’s territorial defence, rather than just fighting wars in distant places.

Cold Response is just an exercise. But it is exercises that keep people fit. The Nordics are looking trim, while much of Europe is still flabby.

Saturday, March 14, 2009

WAS it all a conspiracy? It is not the first time in east European history that the question has been asked. Wicked western manipulators were a staple of communist-era propaganda. Before that, anti-Semitic politicians used to blame Jews (and Freemasons) for manipulating the destiny of other countries. In the 19th century, the German, Austro-Hungarian, Czarist and Ottoman empires kept almost the whole region from the Baltic to the Black seas divided up between the great outside powers.

Now the conspiracy theory is back again. Somebody was spreading rumours. Somebody with foreknowledge or malevolent intent was shorting currencies, stocks and bonds. Someone was using sinister-sounding financial instruments such as credit-default-swaps so that whatever happened, they would profit from a panic. These somebodies could be anywhere, but they are certainly foreign.

Or maybe it is all a plot by Germans to push the Austrian banks into bankruptcy so that they can buy them up cheaply. Or maybe it is a means for “old Europe” to destroy the competitive threat from the unloved “new Europe”. Or a French-German plan to create a core Europe round the euro zone, excluding the troublesome countries farther east. Or it is all some super-clever plot by the ex-KGB regime in Russia, details to be announced later. All that is missing is hook-nosed men in ringlets drinking the blood of Christian children.

The truth is more prosaic. Financial markets are usually wrong, often hugely so. When greed trumps fear they are over-enthusiastic, believing all kinds of positive nonsense and pouring money into dodgy companies and countries. Then the tide turns and they overreact, dumping perfectly good assets in an attempt to get their books in order.

Anyone tempted by the idea that outside conspiracy is to blame for eastern Europe’s woes should first reflect on the past. Was it an outside conspiracy that led supposedly sane Western institutions to lend tens of billions of dollars to Russian companies notable for their weak corporate governance and cash-splattered business models? Was it a western conspiracy that made supposedly sane people buy homes in derelict rural slums in Bulgaria in the belief that it was the new Dordogne? Was it a Western conspiracy that equated the reforms that were promised in the run up to European Union membership with actually making government transparent and efficient?

The right word for this is not “conspiracy”. Something like “groupthink” or the “madness of crowds” would be a better term. In any market movement, there will always be people who profit by betting against the herd. The wise investors who bailed out of the Russian short-term treasury bill market in early August 1998 made a packet. Those who stayed in lost a fortune. They left for the airport, in one case vowing that they would rather “eat nuclear waste” than invest in Russia again.

Conversely, savvy investors who bought at the bottom of the market in late 1998 have done well. A few years later nuclear waste was back on the menu, as investors praised the stability and prosperity of Vladimir Putin’s regime and guzzled anything in sight. Anyone who said that the good times came from rising oil prices rather than real reform was drowned out in a chorus of hurrahs. Again, some people sold their Russian assets in time. No conspiracy there, just foresight, or luck.

As so often with market downturns, the pain and unfairness now seem intolerable. It may perhaps be some consolation that the gloomiest and most ignorant outsiders are those most likely to lose out.

THE Nazis succeeded in exterminating millions of Jews. But they did not succeed in extinguishing their history. That is the story told by Samuel Kassow, an American historian, in a poignant and detailed account of the secret archive of the Warsaw ghetto.

In the autumn of 1940, Warsaw’s Jewish population, swollen by forced immigration, amounted to nearly 450,000 people, all of them walled into an area covering less than four square kilometres. By early 1942 about 83,000 had died from hunger. That summer 300,000 were sent away to death camps, mostly to Treblinka. In April and May 1943 the remaining 60,000 were killed, or captured and deported, in the Warsaw ghetto uprising, during which the Germans levelled that part of the city.

Mr Kassow starts his story amid the passionate arguments among Jews in the declining days of the three great empires: the German, the Austro-Hungarian and the Russian. Was the great dream to be integration? Was it in identification with the surging national consciousness of countries such as Poland, at that stage still partitioned? Was it emigration to a Jewish state in Palestine? Or in the hope of a socialist paradise based on a brotherhood of man rather than ethnic, religious or national affiliation? Or some mixture of the above? Was Hebrew the real language of Jews, or a snooty, artificial distraction? Was Yiddish a degenerate linguistic compromise, or the essential literary and political medium?

After the first world war, those arguments became more pressing. A Jewish state was taking embryonic form in Palestine. The Soviet authorities launched a rival Yiddish-speaking Jewish homeland, Birobidzhan, in a desolate corner of the Russian far east. The newly reborn Polish republic offered the chance of partnership with gentile Poles in a common homeland, albeit one marred by prejudice and discrimination.

The task for Jewish historians in those years was finding an account of their past that would help make sense of the arguments about the present. What role, for example, had Jews played in the Polish monarchy before its dismemberment in 1795? Was the Polish-Lithuanian Commonwealth really a paradise of tolerance, or was that just another myth among so many others? Gentile historians’ accounts were inevitably partial. The Jewish collective memory, with its colourful, folkloristic stereotypes of poor beggars, rich merchants and pious rabbis, was a help, but not an answer. Documents were scanty or missing altogether.

That effort gathered pace after Poland regained its independence in 1918. A pioneer was the young Emanuel Ringelblum, a passionate activist in the left-wing Poale Zion movement. Starting as a student in 1920, he was to become one of his country’s best historians, up to his death in the ruins of the Warsaw ghetto in 1944. Ringelblum is the central character in this book; although it is not a formal biography, the author does an excellent job of accumulating the scraps of information and recollection that have survived the human and archival destruction of the war.

With fine Yiddishist instinct, Mr Kassow does an excellent job too of evoking the atmosphere of those years, particularly the YIVO institute in Wilno (now Vilnius), which was founded in 1925 to give class and clout to Jewish scholarly efforts. The early chapters of the book, full of hope and productive energy, make the final ones all the more effective. The hugely subtle, interesting and complicated world of Jewish thought and culture boiled down to a bitter fight over bread or over scrappy permits; either might hold off death for another few days.

The Jews of the Warsaw ghetto could not prevent their own murder. But thanks to the Oyneg Shabes, the secret archive organised by Ringelblum and other historians, at colossal personal risk, they were at least able to record what they thought, felt and saw. The archive ranged from raw eyewitness accounts to scholarly histories, such as Ringelblum’s own lengthy analysis of Polish-Jewish relations. About 35,000 pages (only a fraction of the whole) survived the war, buried in milk churns and tin boxes. Some were carefully soldered shut; others had leaked, leaving an illegible soggy lump requiring painstaking conservation work. That the documents came to light at all is thanks to the persistence of Rachel Auerbach, one of only three survivors of hundreds of people involved in the project. It was she who went to Warsaw in 1946 and demanded that the cold and hungry survivors of the city’s destruction make the effort to dig out the caches from the ruins.

Locked up for years in the Jewish Historical Institute in Warsaw, the documents have only recently been substantially restored. A full catalogue has yet to be made, but the papers about Ringelblum that Mr Kassow has studied give a vivid, sometimes unbearable, picture of the ghetto’s destruction at the hands of the Nazis, and of the efforts made to preserve a semblance of civilised life that had succumbed to the elemental desire for survival.

The archive also illustrates the tension that exists between the Jewish and gentile experience of the war in Poland. The summer of 1939 had aroused a remarkable sense of solidarity between both peoples; that soon gave way to harsher feelings. Some Polish gentiles outside the ghetto taunted its inmates for their passivity (while at the same time grudging them supplies of arms and ammunition). Nazi anti-semitic propaganda about “Judeo-Communism” had some effect. So did self-interest; dead Jews were unlikely to want their pre-war property back. A poignant short piece by a Jewish poet, Wladyslaw Szlengel, an ardent Polish patriot, sums it up. With no gentile Polish friends left to talk to, he takes comfort in telephoning the speaking clock.

How great it is to talk to youNo quarrels, no wordsYou are nicer, my little time clockThan all my former friends.

It is a pity that the author does not give a little space to the view of the ghetto from the outside. And the use of “Pole” as the antonym for “Jew” may jar with some. Many of the people he writes about would have said they were both. But the book remains an informative and moving reminder of what was lost in the Holocaust and the ingenuity and heroism of those who tried to frustrate its perpetrators.

I am still deluged with work involving the libel case so my journalistic output is very restricted. Sorry

Ruthenia

A glimpse of daylight

Mar 12th 2009From The Economist print edition

Ruthenia was once independent, for one day. Now Ruthenes are getting restive

FOR connoisseurs of obscurity, the Republic of Carpatho-Ruthenia takes some beating. Seventy years ago, on March 15th, it enjoyed its sole day of independence—declared in the morning amid the Nazis’ dismemberment of the then Czechoslovakia, snuffed out in the evening by an invasion from neighbouring Hungary. Its leader, Avhustyn [Augustin] Voloshyn, died in a Soviet jail in 1945; so did many others. Before the world had even noticed its existence, independent Ruthenia disappeared into first the Nazi, then the Soviet empires.

Ruthenians have had little joy since. A list of famous Ruthenes begins and pretty much ends with Andy Warhol: the artist did not himself speak Ruthene, though his parents did. He once said he had “come from nowhere”. Many Ruthenian activists feel that way, too.

A million-plus by the most generous count (but far fewer according to sceptics), Ruthenians are scattered through the Carpathian regions of Slovakia, Poland and Ukraine, with another bunch in former Yugoslavia. Some are Orthodox, but most are eastern-rite Catholics. That prompted savage suppression in the communist era.

Many doubt the Ruthene claim to any form of national identity. Even the placename is disputed. Czechs and Slovaks, looking east, tend to talk of “Sub-Carpathia”; Ukrainians, looking west, talk of “Trans-Carpathia”. Communist rulers denied Ruthenes existed at all. Ukraine recognised them as an ethnic minority only in 2007. The language—sometimes called Rusyn—is dismissed as a mere dialect of established Slavic tongues, even by some who speak it.

But the Ruthenian cause is stirring. In western Ukraine, Ruthenian revivalists have demanded self-determination. One group has even declared independence. Their self-proclaimed prime minister, Petr Getsko, told a Russian government newspaper in December that the “lion’s share” of Russian gas exports to Europe pass through pipelines across Ruthenia.

In Slovakia, self-declared Ruthenians are more numerous, but shun the separatist strivings across the border. Overshadowed by Slovakia’s much larger Hungarian and Roma (Gypsy) minorities, they would be happy with just a little more schooling and broadcasting in their fragile language.

Thursday, March 05, 2009

WHY he did it is still unclear. But the “how” is leaking out. Hermann Simm, a former Estonian official who was one of Russia’s highest-placed spies in NATO, pleaded guilty to treason on February 25th and was jailed for 12½ years. The Estonian authorities have released some details of a case that has had the spook world buzzing for the past year.

Yakovlev, the man who ran Simm

Russia’s foreign intelligence service, the SVR, recruited Mr Simm on his holiday in Tunisia in 1995. He was a prime catch. He had finished a stint as a top policeman, and was starting a new security job at the defence ministry. The approach was made by Valery Zentsov, once a KGB officer in Soviet-occupied Estonia. Mr Simm was neither blackmailed nor, at first, bribed; he just wanted his Soviet-era rank of colonel back. At a third meeting he was put on the payroll, receiving just over $100,000 in all.

Mr Simm betrayed every secret that crossed his desk. There were plenty: as the man in charge of Estonia’s national security system, he organised the flow of all classified military documents in the country and abroad. Once Estonia joined NATO in 2004, he acted as the Kremlin’s eyes and ears on the alliance too (although his poor English, say some, may have limited his usefulness). He also tried but failed to get hold of secrets from Estonia’s security and intelligence services, which are separate from the defence ministry.

In 2002, say Estonian officials, Mr Zentsov was replaced by another Russian handler. Sergei Yakovlev worked for the SVR’s elite S-directorate, which runs “illegals”: spies who acquire a genuine identity in a foreign country. Mr Yakovlev, a near-native speaker of Portuguese, appears to have acquired Portuguese citizenship illegally, gaining a passport in the name of Antonio de Jesus Amurett Graf. Travelling as a business consultant, he met Mr Simm every three months or so, in at least 15 countries in the EU and elsewhere.

The plan came unstuck because of poor spycraft. According to spycatchers elsewhere, Mr “Graf” tried to recruit a senior official in another country, who reported the incident to his own counter-intelligence service. Under scrutiny, the Portuguese was seen meeting Mr Simm. That set alarm bells clanging across NATO. The difficulty was to observe Mr Simm closely enough to build a criminal case without sparking his suspicion. Estonia’s security service is getting many plaudits for this, which culminated in his arrest last September. In a separate prosecution, Mr Simm was ordered to pay 20m Estonian kroons ($1.7m) for the cost of new security systems. The SVR did not immediately reply to a request for comment.

Mr Simm is not the only Russian spy at high level in NATO. Several other countries are apparently following up five leads arising out of Mr “Graf’s” activities. The results are unlikely to become public. The way in which Estonia put Mr Simm openly on trial is striking. In other countries, those caught spying for Russia tend to be eased out discreetly rather than being brought to justice in the painful light of day.

THE economic crisis is still unfolding across the ex-communist world. Amid the genuine worries about jobs and savings are some other concerns—less substantial, but more toxic.

The biggest is resentment of the outside world’s neglect and ignorance. How can western commentators lump Slovenia together with Tajikistan as “ex-communist countries”? Why do people confuse Poland’s sound public finances with Ukraine’s catastrophic ones? Why do the frugal Czechs with their solid banking system get lumped together with spendthrift Hungarians? Why does nobody give the countries any moral or political credit for what they have achieved? If any west European country faced the kind of jarring adjustment now being experienced in, say, Latvia, it would expect political upheavals.

Even those political protests that have bubbled up have been hugely exaggerated. It is quite reasonable—even responsible, one could argue—for the public in Latvia, Lithuania, Bulgaria and other countries to feel a bit cross with the politicians who led them into this mess. Isn’t that what political freedom is about?

On top of outsiders’ neglect and hypocrisy comes abandonment. Having painfully climbed into western clubs after five decades of communist captivity, the most advanced ex-communist countries now feel patronised and excluded. If feckless Greece, stagnant Portugal and overheated Ireland look like going bust, the rich countries of the euro zone will bail them out. But the rules for ex-communist countries wanting to join the single currency are arbitrary, and harshly imposed. Lithuania missed eurozone entry by seven-hundredths of a percentage point. Now Poland and Hungary want accelerated entry into at least the waiting room for the euro, and are snubbed.

It is much the same in NATO. Signals that the new American administration may be thinking of a bargain with the Russians over missile defence (you stop or slow down the Iranians, we stop or slow down our new bases in the Czech Republic and Poland) cause even more twitchiness. So new member states feel that they are in the second class compartment in matters of economic and military security.

Such feelings are understandable, but they are a poor basis for action. It was a similar story 20 years ago, when incredulous Sovietologists had to accept that something called “Ukraine” might become a real country and that the “Soviet Baltic Republics” were actually occupied territories on the verge of regaining their freedom. The West had to wake up rather uncomfortably to the news that tens of millions of people who had once been behind the Iron Curtain were now on their doorstep, eager to compete and integrate. It took several years to get the maps right, let alone to work out how to deal with the countries they depicted.

Gaining membership in the EU and NATO, the great achievement of the past decade, took years of hard slog for the countries concerned. The aim then—at least for the most ambitious applicants—was not just to meet west European standards, but to beat them. That happened quickly in some bits of the business world, but the same transformation often lagged in public administration, education, health and transport.

None of that mattered much in boom times. But it meant the ex-communist countries entered the current stormy weather in less than top condition. All too often, their public finances were soggy, bureaucracies unreformed and politicians complacent. The best way to change perceptions is to make them utterly inaccurate, not blame people who hold them for their ignorance, however galling it is.

Europe is facing nightmarish problems in its east. With help from the West, meltdown can be avoided

Correction to this article

IF YOU mix East Asia from 1997 with Latin America in 2001, do you get eastern Europe in 2009? Already worried, financial markets are pricing in the likelihood that one or more of the ex-communist countries in the region will default on its debt.

The biggest weakness lies in a financial system that has combined badly run local banks with loosely overseen subsidiaries of Western ones. During the boom years, this system gobbled up credit from abroad, leading to yawning current-account deficits. Both kinds of banks now have souring loan books—the result of reckless lending, often in foreign currencies. Some local banks have failed; many of the foreign-owned ones now depend on their parents’ willingness to keep financing them—and those parents have plenty of problems at home. The Greek government has told its banks to draw back from their lending in the Balkans. Austria’s lending to eastern Europe is equivalent to about 80% of its GDP.

If finance is the immediate worry, the global downturn is causing plenty of other problems. Exports of manufactured goods to western Europe have plummeted; remittances from migrant workers employed there will also surely fall. Ukraine, dependent on exports of steel and coal to Russia, seems to have abandoned the deal it struck with the IMF only three months ago as part of a $16.4 billion bail-out. Latvia, also rescued by the IMF, is expecting a 12% fall in GDP this year. The collapse in output is likely to be as big as Asia’s ten years ago—but with a twist. The Asian countries recovered thanks to export-led growth. Now the whole world is in a mess.

What can the governments do? In many places the policy levers look flimsy. Countries such as Poland and the Czech Republic have cut interest rates to help ease the pain—but this has sent their currencies tumbling, increasing the agony for households that have mortgages in Swiss francs or euros [bad wording here--I meant for Hungarian and Polish households, not Czech ones.EL]. Some countries have an extra problem of big external government debts (in Hungary’s case, the gross figure is near 100% of GDP)[another mistake, I meant gross as in private and public combined]. Even those that could perhaps afford to run a counter-cyclical policy to offset the effects of the downturn are squeezing public finances—in part because they think that cutting deficits will help them reach the (presumed) safety of the euro zone.

For four countries—the three Baltic states plus Bulgaria—the strong euro is a problem; they have pegged their currencies to it. Some fear a repeat of the doomed struggle to keep Argentina’s currency board afloat in 2000-01; or perhaps worse if one currency’s collapse swamps others. As for help from abroad, the IMF can give instructions to individual countries, but it cannot run the whole region. The European Central Bank, which is not a lender of last resort even to banks in the euro zone, has been sniffy about lending to countries outside it.

Worse for some, much worse for others

A very nasty recession is inevitable, but regional catastrophe is not. For a start, talk of “eastern Europe” is imprecise. The woes of Kazakh banks or of Ukraine’s public finances have little to do with the countries, mainly smaller, richer and better governed, that are already in the EU. If Ukraine defaults or (more likely) is forced to restructure its debt, it need not hurt others. Though the region has allowed startling imbalances to develop, foreign-exchange reserves are generally stronger than in Asia ten years ago; and there is less light-footed “hot money”.

For the new EU members, there is also the prospect of help from the West. Their banking systems are far more intertwined than Asia’s were—and the foreign banks are less likely to walk away (see article). The Baltic countries have been bolstered by a Swedish guarantee covering Swedish banks that operate there. Although the EU and the ECB may not want to get involved in bigger bail-outs, they will have to. Even the most short-sighted west European politician will surely not send his neighbours into economic and political anarchy.

This is the most perilous period for east European countries since the collapse of the Soviet Union. People there are going to be a lot poorer and (justifiably) crosser. But it would take a bout of wilfully destructive protectionism and the demise of the EU’s main institutions to turn that into disaster.

AMID the wreckage of Latvia’s retailing industry, which has declined 17% year on year according to the latest figures, one item is selling well: T-shirts with seemingly mysterious slogans such as “Nasing spesal”. Latvians are glad to have something to laugh about, even if it is only their finance minister, Atis Slakteris. In an ill-judged foreign television interview, using heavily accented and idiosyncratic English worthy of the film character Borat, he described his country’s economic problems as “nothing special”.

Put mildly, that was an original interpretation. Fuelled by reckless bank lending, particularly in construction and consumer loans, Latvia had enjoyed a colossal boom, with double-digit economic growth and a current-account deficit that peaked at over 20% of GDP. Conventional wisdom would have suggested applying the brakes hard, by tightening the budget and curbing borrowing. But the country’s rulers, a lightweight lot with close ties to business, rejected that. Fast economic growth made voters feel that European Union membership was at last producing practical benefits, after a disappointing start when tens of thousands of Latvians went abroad in search of work, leaving rural villages and small towns depopulated.

The central assumption, in Latvia and many other countries in or near the EU, was that convergence with rich Europe’s living standards and other comforts was inevitable. Lending in foreign currency went from 60% of the total in 2004 to 90% in 2008. Why pay high interest rates in the local currency, the lat, when the cost of a euro loan was so much cheaper? In a few years Latvia would surely join the euro anyway. Similarly, worries about financing the inflows were dismissed: Swedish banks would no more abandon their subsidiaries in Latvia than they would pull out of, say, southern Sweden.

Last year tested those assumptions nearly to breaking point. First, Latvia’s housing bubble popped. Then the main locally owned bank, Parex, went bust and had to be nationalised, amid fears that it could not pay two syndicated loans due this year. In December Latvia accepted a humiliating €7.5 billion ($9.56 billion) bail-out led by the IMF.

The big cuts in social spending that the package entailed led to vigorous public protests. Now the government has resigned. At a time when strong leadership and public trust are needed more than ever, the country’s squabbling and discredited politicians look hopelessly out of their depth. Latvia is an economic pipsqueak, with just 2.4m people. But the rest of the region is watching nervously, fearful that more bad news from the Baltics could bring others crashing down too.

It is easy to be pessimistic. This is indeed the worst economic crisis since the collapse of the communist planned economies and the wrenching process of privatisation, liberalisation and stabilisation that followed. The main ex-communist economies are likely to contract by 3% this year, according to Capital Economics, a consultancy. Yet the picture is not uniform.

Only a few countries have needed an IMF bail-out. One is Latvia, whose economy is set to contract by at least 12% this year, and whose credit rating has just been downgraded by Standard & Poor’s to junk. Another is Hungary, burdened with a larger debt-to-GDP ratio than almost any other new EU member. It received $25 billion in October and faces a contraction of up to 6%. A third is Ukraine—chaotically run, corrupt and badly hit by the slowdown in its main export market, Russia. Ukraine’s IMF deal brought it $4.5 billion in November. But a second tranche of $1.9 billion is stuck; the deal is unravelling as politicians squabble over spending cuts. Its economy is likely to shrink by 10% this year. Other countries with IMF packages agreed or pending include Belarus (a Russian ally which is still expected to see growth this year), Georgia (which was bailed out after last year’s war with Russia) and Serbia.

Most other countries in the region are faring much better, though. Poland—by far the largest economy of the new EU members—is nowhere near collapse. Unlike its central European neighbours, it is big enough not to depend chiefly on exports to the rest of the EU. By European standards, its public finances are in fairly good shape. Its debt-to-GDP ratio is below 50%. Growth will be negligible, or slightly negative, but nobody is forecasting a big decline. Some Polish firms and households have taken out foreign-currency loans—but the figure is around 30% of all private-sector lending, compared with twice that in Hungary.

The second-biggest economy, the Czech Republic, is in good shape too. Its economy may shrink by 2%, but it has a solid banking system and low debt. Its neighbour Slovakia is in better shape still: it managed to join the euro zone this year. Like Slovenia, which joined two years ago, Slovakia can enjoy the full protection of rich Europe’s currency union, rather than just the indirect benefit of being due to join it some day.

Farther afield, the picture is very different. For the poorest ex-communist economies, the problem is not financial meltdown. They lack much to melt. Their exports are raw materials, agricultural products and people. In six countries, money sent home by foreign workers counts for more than 10% of GDP (in Tajikistan and Moldova it is more than 30%). Outsiders who agonise over the Latvian lat or Hungarian forint are rarely bothered with worries about the somoni (Tajikistan), leu (Moldova) or manat (Turkmenistan).

That highlights an important problem. Outsiders tend to lump “the ex-communist world” or “eastern Europe” together, as though a shared history of totalitarian captivity was the main determinant of economic fortune, two decades after the evil empire collapsed. Though many problems are shared, the differences between the ex-communist countries are often greater than those that distinguish them from the countries of “old Europe” (see table).

They range from distant, dirt-poor despotic places to countries in the EU that are not just richer than some of the old ones, but have better credit ratings, sounder public finances and stronger public institutions. In almost any contest for good government, stability or prosperity, Slovenia (under a sort of communism until 1991) looks better than Greece, which invented democracy and was never communist.

Historical and geographical quibbles aside, what the ex-communist countries have shared over the past decade is a mighty thirst for capital. Having missed out on decades of growth and integration with the outside world, almost all (a few oddballs in Central Asia aside) are trying to catch up. Money from abroad has come in from borrowing on the bond market, from foreign direct investment or from selling shares. Most often it has come through bank loans.

At one extreme is Russia, which enjoyed huge external surpluses thanks to its wealth of raw materials. But its big companies borrowed lavishly on the strength of that, creating a potential short-term debt problem. Russian corporate borrowers have to pay back around $100 billion this year. At the other extreme lie countries such as Slovakia. They attracted billions from foreign car manufacturers, drawn by a skilled workforce, low taxes and decent roads in the heart of high-cost Europe.

Countries that relied chiefly on foreign direct investment are the least vulnerable now. The new factories may shut down. But it is harder for that capital to flee. Those that rely on foreign investors buying their bonds, such as Hungary, are the most vulnerable: their fortunes vary with every twitch of a trader’s fingers. In the middle are those that rely on lending from foreign banks to their local subsidiaries. That looked solid in the boom years, as Western banks scrambled to win market share by offering good terms to borrowers and lenders in the fastest-growing bit of Europe. It is still highly unlikely that any Western bank will pull the plug on a subsidiary anywhere—even in troubled Ukraine.

But nerves are jangling. The ex-communist countries have survived the first phase of the crisis, thanks to their own policies and some external support. The second phase, in which the rich world is turning stingier and possibly more protectionist and lenders are scurrying to safety, may be harder. The ex-communist economies must repay or roll over a whopping $400 billion-odd in short-term borrowings this year. Coupled with the lazy but easy lumping of nearly three dozen countries together, that creates the region’s biggest danger: contagion (see article). In other words, failure in one place sparks a disaster in another, even though it may be far away and have the same problem in a far more manageable form.

Contagion could happen in many ways. One is if depositors lose confidence that their savings are safe. So far, Western-owned banks have enjoyed rock-solid credibility: more so, in many cases, than governments or other public institutions. But that confidence could be undermined. If only one foreign bank pulls the rug from under one local subsidiary, leaving depositors stranded, it will cloud perceptions of banks’ reliability across the region. The most dangerous kinds of bank runs would be those in which depositors try to pull out either their foreign currency, or local currency which they would then attempt to convert into hard currency. In some countries that could overwhelm the ability of the central bank to support the financial system.

Another weak point is where shareholders take fright. If a foreign bank with big exposure to the region—Swedish, Austrian or Italian—needs to raise more capital but finds that outsiders think its loan book is too risky, what happens? The price of rescue may be that it sheds a troubled foreign subsidiary. Signs of shareholder twitchiness are growing (see chart).

For now, the most likely source of contagion is collapsing currencies. The paradox is that for countries with floating exchange rates, an orderly depreciation would in normal circumstances be a good way of cushioning an external shock, such as the slump in export markets now hitting the ex-communist economies. It stokes competitiveness and, along with lower interest rates, it lays the foundations for a return to growth. Governments with sound public finances might also consider running a looser fiscal policy to counteract the downturn.

For most of the countries in the region, such a textbook response is out of the question. Some have currency boards, or pegged exchange rates. In the Baltic states these have been the centrepiece of economic policy for more than 15 years. Abandoning them would not only bankrupt big chunks of the economy that have borrowed in euros. It would also be a huge psychological blow to public confidence in the whole idea of independent statehood. These countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting all the benefits.

Countries with floating exchange rates have a bit more room for manoeuvre. Their problem (a big one in Hungary, a lesser one in Romania and Poland) is that falling exchange rates may bankrupt the firms and households which have, in past years, taken out unwise loans in foreign currencies, chiefly euros and Swiss francs. That was, in effect, a convergence play. If you believed your country was heading for the euro zone some time in the next few years, then why not take advantage of the low interest rates there, rather than suffer the higher ones in your domestic currency?

What seemed a minor risk back then now looks painfully mistaken. For those earning forints or Polish zloty, the big swings in exchange rates in recent weeks have sent the size of both loans and repayments spiralling upwards. The zloty has dropped 28% and the forint 22% against the euro since the middle of last year. If the East Asian crisis of 1997 is any guide, these and other currencies may yet have further to fall.

This risk of a currency collapse will limit these countries’ options. So far many big central European countries have cut interest rates heavily to try to boost their economies—Poland’s central bank cut its policy rate again this week. But currency weakness will limit their room for manoeuvre. The Czech, Hungarian and Polish central banks issued a co-ordinated statement this week hinting they might intervene to support their exchange rates. But that route is tricky. Russia has blown half its reserves in a series of unsuccessful attempts to try to prop up the rouble.

Spending and tax policies would be another way of dealing with a downturn. But these are constrained, too. Those countries with a chance of joining the euro are scrambling to cut their budget deficits to get them in line with the 3% of GDP target set by the EU’s Maastricht treaty. Yet that aggravates the problem. The danger for Latvia and Ukraine is a downward spiral, where cuts in public spending damage the economy in a way that helps to entrench the deficit.

So far, the economic crisis has not translated into populist or protectionist politics. It is the east European countries that have been demanding that the rest of the EU stick by the rules of the single market. Their development over the past decades has been thanks to the free movement of capital, goods and labour. They would like a lot more of it: in a contest to subsidise industries, rich countries always win.

But that stance will not hold indefinitely if things get worse. Willem Buiter, a prominent economist, believes it is only a matter of time before some of the ex-communist countries introduce capital controls. That, in theory, would allow them to concentrate on stabilising their economies without worrying so much about the external value of their currency. If voters find the economic pain of adjustment unbearable, politicians can pass laws that will make foreign-currency borrowings repayable in local currency. That would be met with fury by the foreign banks, who would in effect see their loan books expropriated. But it could happen.

Against that background, what can be done? The east European countries are, belatedly, co-ordinating their approach within the EU, holding their own mini-summit on March 1st. They want to embarrass countries such as France for what they see as its protectionist approach to the crisis. They are supporting each other: the Czech Republic and Estonia were among those contributing to the Latvian bail-out.

But even co-ordinated local efforts are unlikely to make much difference, given the scale of the problem. The real lead, and the real money, must come from outside the region. That brings into play a slew of political problems. Having trumpeted their free-market principles in past years, and dismissed the stodgy approach of countries such as Germany and France, the new EU members from eastern Europe are now turning to old Europe in the hope that it can hurry up the flow of EU structural funds to counteract the downturn, bail out or prop up over-exposed banks in places like Austria, and stretch the rules of the European Central Bank to let it provide support to countries outside the euro zone. The case for such measures is strong, and it is in the interest of all Europe that contagion is contained. But that does not mean that it will happen.

New blog!

This site is no longer active. Please go to edwardlucas.com/blog instead

Regards

Edward

Bene Merito award

Without my foreknowledge, I was last year awarded the Bene Merito medal of the Polish Foreign Ministry. Although enormously honoured by this, I have sadly decided that I cannot accept it as it might give rise to at least the appearance of a conflict of interest in my coverage of Poland.

About me

"The New Cold War", first published in February 2008, is now available in a revised and updated edition with a foreword by Norman Davies. It has been translated into more than 15 foreign languages.
I am married to Cristina Odone and have three children. Johnny (1993, Estonia) Hugo (1995, Vienna) and Isabel (2003, London)